ROI: The Age of Reason

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It all started not long after Michael Kutschenreuter joined Siemens Information & Communication Networks (ICN) in April last year. Results for the quarter ended June 30th were devastating — Ebitda was minus $558 million (E563 million), compared with $132 million for the same period the previous year. Demand for its products was decreasing, while competitive pressures were increasing. And board members in Munich were growing more and more impatient to see evidence that ICN’s $1.19 billion restructuring effort was working. Out of frustration, Kutschenreuter fired off an internal memo in July, warning that the $12.9 billion division of Siemens, the German electronics and engineering giant, was “virtually bankrupt” and called for drastic measures in order to put ICN back on course.

While the rest of the firm digested the memo, the 47-year-old Siemens veteran went to work addressing ICN’s woes. “It was clear that my hands were tied as far as growing the top line of the business was concerned,” he says. “But what I could do was look within the company to see where we could cut costs and tighten spending. IT was a logical place to start.”

For sure, Kutschenreuter isn’t the only finance chief who wants to get more bang out of every IT buck. Gone are the go-go 1990s, when companies used the economic boom and dot-com mania to justify their bloated IT budgets.

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These days companies insist that they’ve come to their senses. Ever since economies worldwide began their descent last year, all sorts of corporate technology projects have been scaled back or cancelled altogether.

Sense and Sensibility

So does this herald a new, more prudent era of corporate IT management? It’s too early to say. Surveys from various IT research houses indicate that the days of lavish spending might be over, yet companies are acutely aware of technology’s importance in driving internal efficiencies and competitive superiority, and are loath to cut back too much on IT. A recent poll carried out by IDC and sponsored by Microsoft of 550 large European companies found that nearly 40 percent of respondents are spending the same amount on technology as they did last year, while 43 percent have increased spending.

But companies by now should have learnt their lessons, says Dale Kutnick, CEO and co-research director of Meta Group, an IT consulting and research firm. He reckons that IT strategies now need to reflect a new cost-consciousness while, perhaps more importantly, focusing on monitoring the performance of investments. As he puts it: “It’s no longer about how much you spend, but how you spend.”

That explains why corporate bosses aren’t asking for, but demanding, quick payback times, thorough business plans, and careful, regular pre- and post-implementation analyses of all major technology projects. For some CFOs, that means re-introducing their companies to old IT-investment disciplines that had fallen by the wayside in the rush to E-business. For many others — Kutschenreuter included — it means developing entirely new methodologies to ensure that their IT portfolios deliver more value than they have in the past.

At ICN, it’s been nothing short of a revolution. “IT investments used to be made without much discipline. Not anymore,” says Kutschenreuter.

When he joined the firm, benchmarks revealed that the cost of IT as a percentage of revenue at ICN — a figure Kutschenreuter declines to disclose — was uncomfortably high. The trouble was that ICN had grown rapidly through acquisitions over the past few years and had inherited a number of IT systems that were nowhere close to being integrated with ICN’s own infrastructure. Flummoxed, Kutschenreuter gave up trying to count how many legacy applications the company was running — the number of ERP systems alone was “in the double-digit region,” he says. “Of course, this can’t be efficient.”

That wasn’t the only thing that rankled ICN’s finance chief. As he saw it, ICN’s IT spending habits had been allowed to slide out of control during the dot-com boom. “All the E-business hype was driven by new tools — CRM, SCM, you name it — and we spent a lot of money on them,” he says. “As long as we were profitable, people really didn’t seem to mind.”

Kutschenreuter reckoned he could change all that. “A CFO can do more than just concentrate on those traditional tasks like reporting and controlling,” he says. “The CFO has the overview of the internal processes and rather than just saying to the rest of the company, ‘We have to cut costs’, we can actually show them the way and give them the tools to do that.”

Hence a colorful display of charts and tables on Kutschenreuter’s laptop screen today. The display is the culmination of a yearlong project aimed at radically transforming how IT investments are made throughout ICN. On one side of the screen, a series of columns show the financial impact of a proposed supply-chain application up to 2005. On the other, a chart plots the risk-return analysis of the project.

CFO + CIO = ROI

The idea to roll out a single, standardized ROI methodology took off last summer after Kutschenreuter held a meeting with Stefan Langkamp, ICN’s CIO, to discuss technology spending. “As soon as we decided on the methodology, we moved fast,” Kutschenreuter recalls. “In four weeks we made our first ROI calculations,” and though, as he concedes, the software wasn’t “100 percent perfect, it was a good start.”

One of the main principles of the ROI program is centralization. Before Kutschenreuter arrived at ICN, the buying and managing of IT were decentralized and fragmented functions. “The business units used to make all the decisions, and the IT department’s job was to fulfil their requests,” he recalls.

The trouble, says Kutschenreuter, was that no one was held accountable for driving a companywide IT strategy, and it was hard for head office to get an accurate overview of spending trends. “It was really difficult to make the right investment at the right time in a way that would bring value to the entire company, not just individual business units.”

No longer. When business units have a project proposal today, they must complete a lengthy questionnaire about the tangible and intangible benefits they expect the project to achieve if approved. From there, all valuation and analysis is handled by the IT department, not the business units.

When designing the company’s ROI program for IT projects, managers at Siemans agreed that all projects should be assessed according to the same metrics. One of those metrics is Economic Value Added (EVA), which the entire Siemens group has been using since 1998 to measure all major investments. “We didn’t want to reinvent the wheel, and we wanted to make sure we used something that everyone was familiar with,” says Beate Stadler, director of ICN IT.

Yet as Kutschenreuter explains, EVA alone can’t tell the whole story. “With IT, we can’t just do a mathematical calculation (based solely on EVA) because there are ‘soft’ factors — such as higher quality of data or faster reporting cycles — that a pure ROI calculation doesn’t consider.”

Taking information from the questionnaires, the IT team converts the intangible, soft benefits into a numerical weighting and aggregates them to produce a ranking of between zero (for projects bringing the least value to the company) and 500 (for projects bringing the most value). The results are then plotted on a four-quadrant chart, with ROI on the X axis and the value ranking on the Y axis.

The software tool also handles “what if” scenario planning and risk modeling. The outcomes of those calculations help the IT team determine how much controlling and administration a project will require, and are stored in a database along with all other project information.

Pushing the Reset Button

The final part of the ROI program is stricter post-implementation project management. Kutschenreuter and Langkamp now lead a small IT council, which meets at least every six weeks to run through figures produced by the ROI software. With a few clicks of a mouse, they can see which projects are meeting pre-agreed targets and which aren’t. Those that aren’t are closed down or restructured quickly.

Along the way, there have been some surprises. For example, a few months ago the IT council began studying a big customer relationship management (CRM) project that was developed in-house after several business units requested it. “We calculated that the project would cost us $3 million to $4 million a year just to keep it up and running,” says Kutschenreuter. Meanwhile, a survey of the tool’s users also showed that they were only using parts of the tool and that cheaper off-the-shelf products could do the job just as well. On top of that, ROI figures showed that the CRM project would never be profitable.

“That’s when we decided to hit the reset button,” he says. “And the good thing is that there wasn’t the usual tension you find between IT and business units. No one could argue with the ROI calculations.” In the end, he says, the business units and IT reached a consensus to close down the project and migrate to a cheaper solution.

Today, IT costs as a percentage of revenue have dropped significantly. One of the reasons for the decrease, says Kutschenreuter, is that the ROI tool produces cold, hard numbers that show the business units why many of their beloved legacy systems cost much more to keep up and running than standardized platforms do. “They suddenly see that it’s possible to get rid of their legacy systems and implement new ones,” he says. “This is the charming thing. You can invest in new technology and at the same time you’re saving money by closing down old systems.”

The next stage, says Kutschenreuter, is to tie the ROI program to planning and performance measurements. In the current round of budget preparations, for example, the benefits claimed by the business units for approved IT projects are included in targets set for the next fiscal year, which begins in October. Eventually, Kutschenreuter would like to see annual bonuses linked to how well those targets are met by business unit heads.

When Kutschenreuter accepted the offer to become finance chief at ICN, he promised himself one thing: Within three years, it would return to its star position at Siemens. His work may not be finished yet, but if his IT investment management is any indicator, he appears to be on the right track.

Evangelize and Analyze

Same thing can be said for François Coste. Coste, regional CFO of Axa Asia Life, the Hong Kong-based insurer with $5.94 billion in assets under management, has long been evangelical when it comes to CFOs and their ability to drive the value of IT investments. “IT is not something mysterious where CFOs shouldn’t enter,” he asserts.

But his evangelism has been even more pronounced ever since late last year, when Axa’s headquarters in Paris called for a major initiative to retool groupwide technology management. A key to executing the plan, says Coste, is having a clear framework in which to categorize IT projects. Now, every euro spent on IT at Axa should achieve one of three goals: Generate revenue, reduce costs, or maintain and develop infrastructure.

To make this happen, Coste ensures that all proposals at Axa Asia Life undergo rigorous pre-investment analysis. “We spend as much time as possible doing feasibility studies,” says Coste. “Taking the time upfront saves us money in the long run because once something moves beyond the design phase, it’s often too late to pull back and stop spending.”

Coste, who sits on Axa Asia Life’s IT steering committee, explains that such rigor often involves making tough tradeoffs when allocating the annual IT budget. He recalls, for example, recently receiving a strong proposal from several offices in Asia which wanted to migrate their financial systems to one used in another part of the company. “We could demonstrate some significant efficiency gains in finance by having a more integrated system, but the major benefit — improving the quality of data — wasn’t tangible enough to quantify.”

What’s more, in studying Axa Asia Life’s entire portfolio of IT projects, other proposals were stronger, particularly those that would develop new marketing channels and products. “Now, whenever we look at an IT project, we always look for what it will mean for us in terms of business results,” he says. “It’s not rocket science, it’s just best practice.”

For the group, that best practice is already bearing fruit. Axa reckons it’s saving $150 million a year now that over half of all IT spending has been centralized within the insurer’s various regional headquarters. Encouraged by the success, the company wants to cut groupwide IT budgets by 30 percent by 2003. Coste, for one, has no doubt that the target will be met.

Some Art, Some Science

For most, figuring out what the targets are can be tricky.

Just ask Don Hughes. Hughes, CFO of Lands’ End, is no pushover for glamorous, new technology. At the American catalog and online retailer, he requires all IT projects costing more than $25,000 to include a rigorous “concept and feasibility” study to determine whether they will produce an internal rate of return (IRR) of 12 percent, the minimum IRR the company allows for all major investments.

Hughes, however, is willing to make exceptions to the rule. A case in point: My Virtual Model, a pioneering onsite feature introduced to landsend.com in 1998, which lets shoppers draw a 3-D screen image of themselves and “try on” clothes and other merchandise.

“Certainly questions about metrics got asked (when we looked at the business case). But the answer was, ‘We don’t know what the return on our investment will be’,” Hughes says. “We couldn’t look out in the world and point to a peer to know what kind of lift it received in average order value or frequency of ordering or any other revenue-enhancement metric as a result of installing a similar tool. We had nowhere to turn.”

So how does Hughes know whether to give projects like My Virtual Model the green light? “It’s clearly part art and part science,” asserts the 15-year Lands’ End veteran, adding that over time he has steadily developed “a deeper understanding of what makes our business tick, and what our customers want”.

Jeanne Ross at the MIT Sloan School of Management in Massachusetts is among the IT experts who laud Hughes and other CFOs like him who aren’t over-reliant on IRR, net present value, or other traditional ROI measures that she finds can be too constraining. “I hate to put down CFOs, but more often than not, the ROI mindset comes from them,” says the principal research scientist at the Center for Information Systems Research at Sloan. ROI, she explains, “can be too much of a good thing,” encouraging companies to choose small, cost-cutting projects over large, visionary ones.

That’s because ROI measures the former with more precision than the latter, which can involve a lot more assumptions when making forecasts. “In visionary projects, you need to separate the business case from the metrics,” she says. And at some stage, a decision to make an investment comes down to what she calls “organizational intuition.” Others — like Hughes — call it a gut feeling.

But no matter how strong his gut feeling might be about a project, Hughes says he still “likes to challenge assumptions regularly.” So when he and the rest of the IT committee meet for half a day every month, they focus on “after-the-fact” analysis of all ongoing projects, “to make sure that we haven’t signed up for a $1 million project that’s actually going to cost us $2 million.”

Hughes has good reason to be proud of his IT track record. Last year, online orders accounted for around $325 million of its $1.6 billion annual revenue, and the company claims that Web sales are currently growing three times faster than its catalog purchases. “If we were a pure hard ROI company, we would not be in the position we’re in today,” asserts Hughes.

Its thriving online business has certainly impressed another retailer — in May, Sears, Roebuck & Co., whose chain of department stores spans the United States, announced plans to buy Lands’ End for $2 billion in cash. Under the deal, the two firms will operate separately, with the Lands’ End catalog and Internet business remaining at its current headquarters in Wisconsin — under Hughes’s watchful eye.